Occasionally we find a delectable property that is owned, alas, in a C-Corporation by some unfortunate chaps. C-Corps that have real estate operations as the primary line of business face significant tax issues when liquidating assets.
The challenge for these C-Corps is that the gain-on-sale is taxed at corporate rates including federal, state and local, rather than the capital gains rate. Thus, a C-Corp might pay a 45% aggregate corporate tax rate on the gain-on sale as opposed to a 15% capital gains rate.
Owners of the C-Corps would prefer to sell the C-Corp rather than the underlying commercial real estate asset(s). However, buyers of these problematic C-Corps are tough to find. As David Stone, President of Stone Capital Advisors explains, “Buyers are seldom interested in buying shares of a corporation owning real estate because they would inherit the lower cost basis and forgo any depreciation write-offs.”
The solution is to find a third-party Investor that will purchase the corporate shares from the Seller and then sell the property to the buyer. As Stone explains, “Once the investor has purchased the shares of the selling corporation, the corporation then completes the sale of the property to the ultimate buyer.” The investor then defers its tax liability by reinvesting the proceeds into a like-kind exchange property (I.R.S. Section 1031) to permanently defer the gain on the corporate asset sale. Under this structure, the seller typically receives a 25%-30% increase in after-tax proceeds compared to the C-Corp selling the property directly to the buyer. The buyer receives the benefit of a stepped-up tax basis for depreciation purposes.
Stone provides an actual transaction to illustrate the financial results. The selling shareholders of a corporation owning a $50M asset would have realized after-tax proceeds of $30M if they sold the asset directly to a willing buyer. However, a transaction was structured so that a third party Investor stepped in and paid $40M for the stock of the corporation. As the Selling shareholders did not pay tax on the gain of the asset, they realized $40M, a $10M or 33% increase in after-tax proceeds.
As had been previously agreed to, the investor then sold the asset to the ultimate buyer for $50M. The buyer got the property, the seller realized higher after tax proceeds, and the Investor benefited from the spread and having and an investment in the 1031 property.
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